Slowing Economy, Bullish Market!

After a consolidation of over six months the S&P 500 broke its downtrend
line from the March 2004 highs on October 4. So is this it? The long awaited
third leg up for the bulls? The move that will take the S&P 500 to its
next level of nirvana at 1225 to 1275. We don't think so but we can never rule
out a fool's gold rush. Key to this is that the S&P never trades back under
1120/1125. Knowing this one could continue to scalp long to the nirvana levels
even if you don't believe it. And the sectors that must perform in order for
this to be achieved are the financials, healthcare, information technology
and of course consumer discretionary for if the consumer is not there adding
to his bloated credit card debt then this doesn't stand a chance.

Of course the major Wall Street and Bay Street firms will never tell you that
things are about to go to hell in a hand basket. Without the flow of funds
and commissions from the public they wouldn't be in business very long. But
the truth is we have been going through a drifting market now for 10 months
and commissions are down sharply for the firms so any talk either fundamental
or technical that supports the bullish case is good news. And that we are down
only a little or up a little depending on which market you look at is also
bullish. Too bad the bulls are really trapped in a still overvalued market.

Everyone is still in the market because as we pointed out in an earlier missive
there has never been in the history of the markets a year ending in 5 that
saw a down year. We are reproducing the table below of the history of the 10-year
stock market cycle. We first saw the complete table in the August issue of
the P.Q. Wall Forecast.

Ten-Year Stock Market Cycle
Annual % Change in the Dow Jones Industrials Average
Year of Decade

Decades

1st

2nd

3rd

4th

5th

6th

7th

8th

9th

10th

1881-1890

3.0

-2.9

-6.5

-18.8

20.1

12.4

-8.4

4.8

5.5

-14.1

1891-1900

17.6

-6.6

-24.6

-0.6

2.3

-1.7

21.3

22.5

9.2

7.0

1901-1910

-8.7

-0.4

-23.6

41.7

38.2

-1.9

-37.7

46.6

15.0

-17.9

1911-1920

0.4

7.6

-10.3

-5.4

81.7

-4.2

-21.7

10.5

30.5

-32.9

1921-1930

12.7

21.7

-3.3

26.2

30.0

0.3

28.8

48.2

-17.2

-33.8

1931-1940

-52.7

-23.1

66.7

4.1

38.5

24.8

-32.8

28.1

-2.9

-12.7

1941-1950

-15.4

7.6

13.8

12.1

26.6

-8.1

2.2

-2.1

12.9

17.6

1951-1960

14.4

8.4

-3.8

44.0

20.8

2.3

-12.8

34.0

16.4

-9.3

1961-1970

18.7

-10.8

17.0

14.6

10.9

-18.9

15.2

4.3

-15.2

4.8

1971-1980

6.1

14.6

-16.6

-27.6

38.3

17.9

-17.3

-3.1

4.2

14.9

1981-1990

-9.2

19.6

20.3

-3.7

27.7

22.6

2.3

11.8

27.0

-4.3

1991-2000

20.3

4.2

13.7

2.1

33.5

26.0

22.6

16.1

25.2

-6.2

2001-2010

-7.1

-16.8

25.3

Down years, as you can note are more likely to happen in years ending in 7
or 0. But years ending in 5 have thus far been perfect including the best year
ever in 1915 with an 81.7% gain. Statistically anomaly? Might be. Odds would
tend to increase that as time goes on that a down year could happen.

We know that every Wall Street firm and Bay Street firm plus any money manager
worth his salt knows this. So is it a lay up? It might be but then again ....

We were quite struck with the recent headline of The Economist - Scares
ahead for the world economy, October 2-8, 2004. TheEconomist is
not of course known for being shrinking violets when it is necessary to say
what needs to be said but in reading the article there was a sense of déjà vu.
What they were saying is what we have been reading for so many years at web
sites such www.gold-eagle.com, www.financialsense.com, www.safehaven.com, www.prudentbear.com,
and many others and of course written by the "Scoop".

Of course as the bulls would have it any of the problems even those outlined
in The Economist are not insurmountable and that the market is just
climbing the wall of worry that it always does. So one should just look past
the sharply rising oil prices; that the consumer will hit a debt wall and stop
spending; that housing prices will bust; and, that China will have a hard landing
and instead just stay the course. Those were the risks to the economy outlined
by The Economist. We might add global/political risks which we believe
are equally important, such as the forever war on terror; the US created quagmire
in Iraq; the Israeli/Palestinian conflict that continues to escalate; the threat
of unilateralism by Russia to join the unilateralism of the US; and the threat
of a terrorist attack on US soil. Any of these could roil the markets if an
unexpected event were take place.

The optimistic economic outlook is backed by the forecasts of the IMF, the
OECD, the Federal Reserve and the European Central Bank. Pretty powerful accomplices
to flow with the bullish tune of Wall and Bay Street. So has The Economist lost
its mind and joined the ranks of the doom and gloomers, gold bugs and perennial
bears? We doubt it. Of a number of publications that we read The Economist is
definitely not known for irrational forecasts and statements.

The concerns expressed in The Economist are in some respects looking
more viable as we are continuing to see softness in the job markets with a
very high number of announcements of job layoffs recently; a softening profit
picture; the Fannie Mae problem that could still derail the market as reports
continue to point to serious problems; lacklustre retail sales some related
to the hurricanes but overall seeing softness everywhere once again raising
concerns as to whether the consumer is tapped out; slowly rising interest rates;
continued sharp increases in oil and gas prices which will hit the economy
down the road; continued softening in numerous economic indicators especially
sentiment indictors, and economic activity indicators.

And as we get closer to the election even "Scoop" would have to voice its
desire to see Kerry in over Bush. After all can the US economy afford four
more years of what the first four years of the Bush/Cheney administration has
brought? The statistics are appalling. Average family income has fallen with
median incomes down $1500 in real terms; over one million jobs lost, the first
administration since the Great Depression to see an actual decline in jobs;
the number of Americans not covered by any form of health insurance up by 5.2
million; the number of Americans in poverty up in the last year alone by 1.3
million; a budget deficit that is now 5% of GDP whereas it was a surplus of
2% of GDP in 2000; record trade deficits that are now higher then they were
in 1987 when the markets crashed; and tax cuts that basically only benefited
the richest. And this is to say nothing about the quagmire in Iraq; a war that
was based on lies (no WMD and no ties to Al Qaeda) and that has been deemed
in numerous circles as illegal.

But the markets continue to move higher but even as they move higher the divergences
just seem to get bigger. While the NASDAQ, S&P 500, TSX and the Dow Jones
Transportations have moved to new highs for the move the Dow Jones Industrials
is below even its recent highs. The bulls will rationalize that away with the
problems at Merck but on a pure technical basis these divergences should not
be ignored especially the Dow Theory divergence between the DJI and the DJT.
The bulls site this as a sign that the market will move higher and that the
DJI will eventually catch up we can only note that we would agree if the market
was at a bottom as was readily seen in the October 2002 and March 2003 lows
but it is not at lows it is occurring at highs.

The other major divergence that we continue to note is the one between the
markets and the Volatility indicators (VIX for the S&P 500 and the VXN
for the NASDAQ). These indicators continue to point to extreme complacency
in the markets with the VIX and the VXN hitting record lows even as the markets
remain well below not only their highs earlier in the year but also with the
all-time highs in 2000.

Another negative indicator is the rise in the short interest, as the specialists
are getting shorter as the market rises. The specialists are usually ahead
of the curve. On the other side money flows have continued to be positive but
that might be a result of the sharp monetary growth that has been seen this
year even after July numbers indicated a pull back. Monetary numbers grew sharply,
however, once again in August and continued to rise in September. Even as the
Fed is slowing hiking short interest rates (which still remain below inflation
levels) they continue to allow rapid monetary growth.

On a positive note we can't help but note that the precious metals markets
are rising and are threatening to break out to higher levels. As usual a weakening
US$ is driving gold. Gold can go up even as the broader market goes down but
it can outperform even if the broader market goes higher. This was seen in
2003 when the metals markets outperformed the broader market. So no matter
what happens going forward the precious metals markets appear to be a place
to be. The energy markets also keep going higher but we are approaching some
longer-term targets near $55-$58 for oil. But for the oil and gas markets in
general we see little signs of a significant top forming.

With the important employment numbers due out on Friday October 8 it could
prove to be a watershed. A higher than expected number of course will send
the markets higher but a lower than expected number would confirm that the
economy is slowing and the rational for the bullish markets will weaken considerably.

In our last Scoop we showed a chart of the Dow Jones Industrials and the Dow
Jones Transportations. We are showing this chart once again. The DJT has broken
out of what may be an ascending triangle. But the DJI is not only not making
new highs it is below the highs seen in early September. This is unprecedented
level of divergence we have never seen before. We suppose that one could argue
that there are 5 clear waves seen on the DJI with the 6th wave seen
up to the September highs. But sometimes these corrective waves go to 7 waves
or even 9 waves. So until the DJI clears the September highs and then the June
and February highs this is an unresolved major divergence. We note that at
the highs in 1973 it was the DJI making the new high and the DJT not confirming.
But that happened only once not the three times the divergence has occurred
this time around.

David Chapman is a director of Bullion Management Services
the manager of the Millennium BullionFund www.bmsinc.ca

Note: The opinions, estimates and projections stated
are those of David Chapman as of the date hereof and are subject to change
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